Picture this: It’s on or near Expiration Friday and your stock or ETF (Exchange Traded Fund) is above the strike price. You know that if you do not act to institute an Expiration Friday Exit Strategy your stock will be assigned (sold). So what are the factors that will determine whether or not you buy back the option and therefore keep your shares? Before we even look at the calculations, there are 3 tests your security must pass:
1- Is it fundamentally sound?
2- Is it technically sound?
3- Is there an Earnings Report scheduled for the upcoming contract period?
The first 2 tests are usually passed because the price of the equity has been rising. Make no assumptions…check it out.
ER dates should be noted next to all stocks on your watchlist. Those of you familiar with my system know that avoiding the sale of options prior to an ER is critical to the success of your investments.
Let’s now make the assumption that all 3 tests were passed and we move on to the calculations. Is this financial soldier prepared to enter the investment battlefield and come home with lots of friends? Put another way…how much cash are we going to make? Many option sellers are hesitant to buy back an option because they feel that it is eroding the profit they generated the previous contract period via the original sale of the option. I look at it completely differently. The money we made from the original sale of the option is ours to keep no matter what happens to the stock. That is a deal from the past. If we decide to buy back the option it is only with a concurrent sale of another option in mind. This is a completley separate deal to be evaluated on its own merit having nothing to do with the original option sale. The point here is not to cloud your decision as to whether to buy back an option by factoring in last months option profit.
There is nothing like an example to clarify a point. I will use the most common Expiration Friday Exit Strategy that I invoke. It is called Rolling Out or Foward. The definition of Rolling Out is: Closing out of an options contract at a near-term expiration and opening a same strike option contract at a later date. In the example I am about to give, you sell the September $80 call, buy it back, and then sell the October $80 call. here’s how it works:
1- Buy 100 x Company XYZ @ $78
2- Sell 9/80 strike (put the cash in your pocket, keep it, and move on to the next deal).
3- Current price is $83 near Expiration Friday.
4- The current value of your investment is $8000 because you are obligated to sell @ $80.
5- You buy back the 9/80 call for $3.10 ( $3 intrinsic value and .10 for the negligible time value).
6- You sell the 10/80 @ $6 generating a net profit of $2.90 ($6 – $3.10) or $290 for the 100 shares.
7- Your profit is 290/8000 = 3.6% for 1 month or 44% annualized.
8- Since the strike price is $3 in-the-money you have downside protection as well of 3.8% (300/8000).
So here is your dilemma: Are you willing to accept a 1-month 3.6% return WITH a 3.8% downside protection on one of the greatest performing stocks in the stock universe that is both fundamentally and technically sound? As I always say…no rocket science required here, just common sense. Once you understand how this works, you will be making these decisions in seconds and will not need anyone to tell you what to do (including me).
For purposes of being thorough, I should mention that in addition to rolling out, there are 2 other possible scenarios that will make you tremendous profits with Expiration Friday Exit Strategies. They are:
1- Rolling Out and Up – Out-of-the-money.
2- Rolling out and up – In-the-money.
Calculations for all these strategies are done automatically by the ESOC (Ellman System Options Calculator) using the “What Now” tab. I hope most of you utilize this tab as it can be great source of profits in your investment portfolios.
I will be going into great detail regarding these strategies at my next seminar series in October. Many of you have requested I do a webinar since our readers are located throughout the country as well as internationally. I am trying to make such arrangements. Those who want early notification of these seminars, send me an email with your contact information:
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Last Week’s Economic News:
The market rallied last week when the Federal Reserve announced that it would keep its target federal funds rate @ 2%. The S&P 500 rose 2.9% on the day of the announcement.
Other positive news included June factory orders, which increased at their fastest pace in 6 months and non-farm productivity which rose at an impressive rate given the current economic climate.
Negative news included consumer debt showing its largest monthly increase in more than 6 months.
For the week, the S&P 500 also rose 2.9% to 1296 resulting in a year-to-date return of -10.6%
Industry in the Spotlight- Trucking:
Shares of equities in the Trucking Industry have been appreciating in value both over the last week as well as the last several months. This demonstrates that institutional investors are taking positions in these stocks. In my view, this is the single most important factor in determining which equities to own. If you check the Group Technical Rating for these equities you see an A+. Interestingly, the Fundamental Rating of most of these securities is rather average. This made it difficult to locate stocks in this industry that met our system criteria. I did find two.
One possible explanation for the great group technical and so-so stock fundamentals could be related to the price of fuel. Generating profits in the transportation business had tremendous hurdles to overcome with oil @ $150 a barrel.
Now that there are indications that these prices are coming down and staying down, the prognosis for higher profits is much better. Perhaps the “big boys” are recognizing that and starting to buy up these equities.
To review what the Group technical of A+ is telling us:
– This industry ranks among the best in overall price performance.
– Many of the stocks within the industry are nearly 52-week highs.
– Moving Averages are uptrending.
– Closing daily prices are at the higher end of the trading range.
The 2 stocks that DO meet our sytem criteria are:
Two that come close and may be worth keeping an eye on are:
Once again, for early notification of my October seminar or webinar series, send your contact information to me at:
Best regards to all,